My International Country Index

  1. The annual review of the UK’s benchmark FTSE 100 index, due to take place this Wednesday 9 June, may lead to the inclusion of such exotic-sounding companies as Essar Energy (an India-focused conglomerate), and African Barrick Gold and Petropavlovsk, two mining companies.

    By most measures these three companies would fail UK politician Norman Tebbit’s controversial “cricket test” of Britishness, given that the overwhelming share of their economic interests lies outside the UK. And yet all three are eligible for inclusion in the UK’s leading equity benchmark. How come?

    In the words of Schroders fund manager Andy Brough, the UK equity market has undergone a transformation over recent decades, reflecting an increasing cosmopolitanism with parallels to the world of sport. “Fifty years ago, one North London football team, Tottenham Hotspur, won the English football league with a team consisting of British players. Now another North London team, Arsenal, has recently won the league with a team consisting almost entirely of non-British footballers,” he said.

    In Arsenal’s case, the influx of players from abroad had a heavy French bias, reflecting the team manager’s background. But the ever-growing number of foreign companies coming to London to raise capital reveals much greater diversity of geographical origin.

    Mining companies such as Kazakhmys, Vedanta Resources, Eurasian Natural Resources Corporation (ENRC), Fresnillo, Randgold and Xstrata, with operations and employees spread around the globe, now share FTSE 100 membership with British stalwarts such as Marks and Spencer, Associated British Foods, Sainsbury’s and Cable and Wireless.

    Index compiler FTSE’s membership rules have had to show a certain dexterity to cope.

    If a company is incorporated and listed in a single market, then FTSE’s nationality rules allocate it to that country, as one would expect.

    But if a company is incorporated in one jurisdiction, including emerging market countries, while being listed in another, then FTSE can determine the company’s nationality as belonging to the country of listing rather than the country of corporate domicile. This means that an Indian power company or Kazakh mining concern can end up in a “British” index purely by virtue of having sold its shares on the London Stock Exchange.

    FTSE’s nationality committee gives itself a fair amount of discretion to accept or reject candidates for index membership if companies fall into the latter category. “We take other factors into account including, but not limited to, the investor protection regulations under which the company is governed, the country in which the company is resident for tax purposes, market perception and currency of trading,” the index provider states in its index rules.

    Since April this year, only equities with a “premium” listing, as defined by the UK’s regulator, the Financial Services Authority, can be included in FTSE’s domestic share indices. Premium listings come with extra responsibilities, including the observation of full voting rights, a commitment to pre-emption rights in secondary share issues, and a requirement to “comply or explain” with the UK’s combined code on corporate governance. According to David Hobbs, chairman of FTSE’s policy group, this new regulatory requirement is simply formal recognition of governance standards that were already imposed by the index provider.

    Hobbs explained what he sees as the general objectives of FTSE when compiling an index to reflect the universe of stocks that is tradeable in London.

    “We can’t just look at a company’s domicile – we also have to look at where its shares are listed,” he said. “If a non-UK company has listed its shares only in London, then if we leave it out of the UK index it wouldn’t appear in an index anywhere. So we’ve taken into account what investors tell us: that they want any non-UK companies in the UK equity indices to be as ‘UK lookalike’ as possible. Hence our insistence – before the UK listing rules formalised this – that eligible foreign companies follow pre-emption rules, comply or explain with the combined code, and that they should observe compliance with the UK’s takeover code as far as possible.”

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